6 Things to Know Before Investing in Cryptocurrency

Cryptocurrencies are digital tokens, usually representing a coin, used as a payment method or, frequently, as a form of investment. If you are investing in cryptocurrency for the first time, you should know a couple of things first. Unlike past digital coins, they rely on cryptography providing utmost security and transparency and eliminating the need of a central server or authority, like a bank.

As always, this article does not constitute investment advice. Please do your own research.

The basics first: what makes cryptocurrency work?

Bitcoin was the first circulating cryptocurrency, created by Satoshi Nakamoto, in 2008. Nakamoto made Bitcoin possible by developing a technology called blockchain. The Blockchain is a ledger recording every transaction that ever happened. Instead of being hosted by a central server, it’s publicly available and hosted by anyone wanting to contribute to its security. These transactions are grouped in blocks containing a unique “ID” and information about the block which came before it. CPUs holding a copy of the blockchain are called “nodes”, and they must verify each transaction for validity (they go through the whole chain to check if the block is unique and if has the right information about the block that came before it) before allowing it to be recorded in the blockchain.

To avoid malicious blocks from being added to the chain, even if they look valid by the nodes, a process called “mining” is used to reach consensus about which block is going to be added. Mining is like voting but requires resources, in this case, computational power. The block with the most computational power dedicated to it is considered the legit one. As a reward for dedicating their resources to secure the system, miners which “voted” for the winning block receive some coins. That’s how new coins are issued in the blockchain.

Users can also include a transaction fee to incentive miners to work on their transaction first. Miners have tools to check which blocks are suspicious and which ones are legitimate. Considering that authenticating a block (mining) has a cost (electricity and equipment) and that they won’t receive any reward from mining a block that doesn’t win the consensus, most of them will tend to vote for the valid one. To include a malicious transaction, one would need an infeasible amount of computational power to win against the enormous number of miners who are doing it for the reward (and that’s why Bitcoin never had a security issue in almost 10 years of history). This way, the blockchain can warrant its own safety without the need of any third party to authenticate the validity of its transactions, unlike credit cards or bank transfers.

There are several options of easy and intuitive applications developed for dealing with most cryptocurrencies. Not only that, there are credit and debit cards and several ATMs that deal with cryptocurrencies too.

Learn about altcoins

In essence, altcoins are any cryptocurrency that is not Bitcoin. Although at the time of writing Bitcoin has a larger market capitalization than all other altcoins combined, some of them offer features that BTC currently does not support. Ethereum is a very popular altcoin, and it’s also a platform used to develop other altcoins! These are labeled ERC-20 tokens. ERC-20 tokens are “compliant” with Ethereum (ETH), and most wallets that store ETH are also able to store and convert these tokens to ETH.

Find a trustworthy cryptocurrency exchange

Cryptocurrency exchanges are the platforms to buy and sell your coins. If you want to start investing in cryptocurrency, these sites will be essential. Some platforms allow the user to buy their cryptocurrencies directly with “fiat currency”, using credit and debit cards, or, if they’re selling their cryptos, redeem their money through a platform like PayPal.

The most popular ones are like traditional stock exchanges, in which users can place buy and sell orders of a given currency pair (BTC for ETH, for instance) and set a rate (the market price for each currency is usually clearly displayed and updated on the exchange page), which are added to an order book and eventually liquidated by a party interested in the deal. This kind of exchange usually have Bitcoin as the main “middle currency”, that is, sometimes you may need to convert an altcoin to Bitcoin first to buy another altcoin.

Interestingly, some cryptocurrency exchanges also have their own token. To learn more about this, check out our article about cryptocurrency exchange coins.

Choose the right cryptocurrency wallet

To make a transaction using cryptocurrencies, you need to “sign” it first. It’s a cryptographic signature that proves you’re the person entitled to the funds you’re sending. You sign your transactions with your “private key”. In a similar manner, to receive funds, you use your “public key”. These are a combination of number and letters that can encrypt and decrypt a message.

There are several types of wallets fit for different purposes. They can be initially classified as software wallets (that is, an application installed on the user’s desktop or mobile device), web wallets (a page on which the user logs in and provides an online interface like that of the software wallets) and hardware wallets (specialized devices able to sign transactions with a simple click).

It is important to note that software wallet will only work on the device on which it was initially installed, so it is always important to keep a physical backup of your keys (such as literally writing them down on paper), in case you lose or switch the device, that is the only way to recover your funds and start using other wallets. These software and websites can create a new address (i.e. keys) for the user and make the process of sending and receiving cryptocurrencies easy.

There are many varieties of wallets offering different functionalities. A wallet, for example, may have a minimalist or more intuitive design. Others offer extra protection layers, such as multi-factor authentication, or even support multiple crypto-coins at the same time. In general, software wallets are much safer than web-based wallets. Although it’s convenient to be able to access your wallet anywhere in opposition to a single device, it poses a risk: if somehow your password is leaked, whether you fall into a scam or your device gets invaded, the hacker there’s nothing preventing the hacker to access your wallet.

How to buy cryptocurrencies

Before investing in cryptocurrency, you will first need a wallet that supports it. The simplest way is using a website like Coinbase to buy some popular cryptos with their current market price plus a premium using a credit card and transfer them to your address (public key), an alphanumeric number that can be displayed by your wallet. After the transaction is complete, you can check your new balance in your wallet software.

Besides buying directly from a “broker” website, you can make more “advanced” transactions using an exchange, like Binance, allowing you to place buy orders with any desired rate that can be liquidated if someone else is interested in it.

Cryptocurrencies as an asset class

Finally, before starting to invest in the cryptocurrency market it is important to be aware that it is a hyper-risk asset class. Although the high volatility of cryptocurrencies has made many early investors large fortunes, it also is significantly riskier than investing in assets like stocks or metals.

When getting started investing in cryptocurrencies, it is advisable to start with larger assets like Bitcoin, Ethereum, or Monero, and to diversify into a few different assets. Smaller coins are usually significantly more volatile and carry more risk of failure, hence why it is advisable to avoid them as a newcomer.

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